Bears Beware, II

In my last article Bear's
Beware I warned that shorts were running the risk of getting caught in
an explosive rally as the intermediate cycle was due to bottom. Well, it
did bottom and bears have watched their profits quickly evaporate as the
market has surged out of the intermediate cycle low.

The initial thrust out of one of these major cycle bottoms will usually gain
6-10% in the first 8-13 days. We are now 5 days in and up 6.6% so far. I expect
we will see a test of the 200 day moving average before we see any significant
pull back. These initial moves out of intermediate bottoms don't tend to wait
around as smart money smelling blood in the street pile in quickly.

It's only the little guy, who doesn't understand what has just happened, that
continues to fight the trend change. This is usually about the time that I
see the technicians start calling for this or that resistance level or trend
line to put a halt to the rally. They are, of course, assuming this is a bear
market rally and it will soon be over.

First off, let me say I'm not convinced yet that the cyclical bull is dead.
I would need to see the market come back down and break the recent lows first.
If both the transports and industrials do that then yes, we will have a Dow
Theory sell signal and at that point I would have to assume that the market
has begun the third leg down in the secular bear market that started in March
of 2000.

Now let me say this, bear markets don't begin because of lines on a chart.
They begin because something fundamental is broken in the economy or financial
system. Now we certainly do have a broken financial system, no doubt about
it, but then again this cyclical bull was never built on the foundation that
we had fixed anything in the financial sector. We certainly haven't fixed anything
in the economy with unemployment remaining above 15% if one counts everyone
out of work. No this cyclical bull was built on a foundation of massive liquidity.
I'm not convinced yet that that fundamental base is broken. Only time will
tell.

But even if this is a bear market rally let me assure you that bear market
rallies don't end because of lines on a chart. If you think you are going to
spot a top in a bear market rally by drawing a few trend lines or some meaningless
resistance level you are just kidding yourself. It ain't gonna happen. It never
has and it never will. Lines on a chart don't halt bear market rallies anymore
than they initiate bear markets.

I'll tell you exactly what halts a bear market rally. Sentiment! Sentiment,
at every single one of those rallies during the `07-`09 market, reached bullish
extremes. Not one single rally was halted by a pivot point or resistance level
prior to sentiment reaching extreme bullish levels.

Even after the recent surge, sentiment is still so depressed that it's at
levels lower than most of the intermediate bottoms during the last bear market.
So let me tell you, if you think the market is going to turn tail and run because
it hits the pivot at 1130 or the 200 day moving average, or because you think
earnings aren't going to be rosy, you are going to be sorely disappointed.

If this truly is a bear market then before you even begin to look for a technical
turning point you first have to wait until sentiment does a 180 degree turnaround.
That just doesn't happen quickly after the kind of beating we just got.

Trust me, it's going to take a while for investors to forget a 17% correction
and dare to become bullish again. If I had to guess I would say at least 8
to 11 weeks. Even longer if the next half cycle (due around day 15-20 of the
rally) and full daily cycle correction (due around day 35-45 of the rally)
are strong enough to scare investors again.

The problem with the move out of February bottom was that we got no corrections
and it quickly turned into a runaway move. Those kind of rallies tend to end
with some kind of mini-crash. I started telling subscribers there was a high
possibility of that back in late March and early April. It happened in Feb.
of '07 with the China crash and sure enough, it happened again in May with
the flash crash.

Traders become extremely complacent during one of these runaway moves. At
the April top sentiment had reached levels more bullish than at the top of
the last bull market. As usual, we paid a heavy price for that complacency.
But now we've swung 180 degrees back in the other direction, with sentiment
so depressed it even makes the `09 bottom look positively giddy. That my friends
is the base for another powerful rally.

Actually I won't be at all surprised if the market rallies back to new highs
... even if we have begun the initial topping process of this cyclical bull.
Remember the bear market had already begun in the summer of `07 but that didn't
stop it from rallying back up to marginal new highs in Oct. before finally
rolling over into the second worst bear market in history.

This idea that the markets can somehow magically look into the future is just
ludicrous. I can assure you no one can see the future, and that includes the
millions and millions of investors that make up the global markets.

Now let me say this - we already know where the cancer is. Does that mean
the stock market will now start to discount the next bear market? In the summer
of `07 we knew the cancer was in the credit markets, initially beginning in
the subprime mortgage market. Did the market look into the future and discount
the unraveling of the global credit markets at that time? No it did not. The
stock market rallied to new highs.

Well, we already know what will eventually bring this house of cards down,
it's already started just like it had already started in the summer of `07.
We are going to have one sovereign debt implosion after another and that is
going to lead to the cancer spreading through the global currency markets eventually
infecting the world's reserve currency.

But don't expect the market to look ahead and begin discounting the unraveling
of the global currency markets. Markets don't do that. What they do is slowly
recognize the fact that the fundamentals are broken. Once enough traders realize
that, the markets begin to roll over, usually in an extended process taking
many months.

I doubt this time will be any different, especially since the central banks
of the world are going to fight the bear with a blizzard of paper. Don't make
the mistake of thinking the markets have to act rationally. They don't and
won't. If the Fed prints enough money markets are going to rise even though
the global economy is crumbling all around us.

If you are bearish and determined to pit your stash against Ben's printing
press I'm afraid you are signing up for one very difficult time ahead. I seriously
doubt we are going to see another credit market implosion like we saw in `08.
Without a severe dislocation like that there will be no market crash this time.
When the bear does return (and he will eventually) the next leg down is going
to be a long drawn out process with multiple violent bear market rallies. Selling
short in that kind of market isn't going to be easy. As a matter of fact I
doubt 1 bear in 10 will even manage to make money in that kind of environment.

Bear's should be careful what they wish for. I suspect the next leg of the
secular bear will manage to destroy both bulls and bears alike.

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